Wall St.’s Sheriff of Nottingham

Wall St.’s Sheriff of Nottingham

February 18, 2021
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When I wrote about my concerns regarding online stock trading app Robinhood back in July of last year, I had no idea what was to come in 2021. Nor did I realize fully the dangers associated with Robinhood. In other words, I had no idea “how deep the rabbit hole goes” (I literally just watched The Matrix for the first time in my life so I had to throw that in there). But before I get to any of that, I want to recap the issues that we were seeing already last year.

                My biggest concern with Robinhood and other like trading apps was the marketing towards younger, inexperienced clients and the lack of financial education. I referenced Warren Buffet’s advice that, in the absence of sound advice, the individual investor is better off investing in index funds[i]. I also maintain my criticism of Robinhood’s marketing strategy. They continue to market themselves as a fun, free way to trade while failing to adequately represent the risks involved. Not to mention their recent troubles with the SEC for failing to transparently explain how they make money[ii]. Gamifying investing in the stock market is a great way to lure in young investors but a terrible way to grow an educated, financially literate clientele.

                My second concern was the reliability issues of online trading apps, particularly Robinhood who, last year, saw over 47 outages[iii] that resulted in users not being able to place trades when they wanted to. Which is kind of a big deal. One notable outage occurred for almost 2 days straight[iv] just as the pandemic started heating up and the market dropped nearly 30%.[v] Unfortunately, it would appear that reliability issues still persist in one way or another which leads us to the events of January 2021.

                By now you have likely heard about the insanity that ensued[vi] when a group on an online forum decided to drive up the stock price of video game retailer GameStop at the detriment of sophisticated investors on Wall Street. I will not go into detail here as my focus is Robinhood’s response, but suffice to say it was not a masterclass on prudent financial planning.

                Robinhood came under fire for their response to GameStop’s rapidly climbing stock price. As the stock rose 500%[vii], the online brokerage suspended user’s ability to buy the stock while still allowing them to sell their shares. This has led many to believe that Robinhood did so in order to protect the traders and hedge funds on Wall St. Of particular interest is that Robinhood does have a financial relationship with Citadel Securities[viii], a firm which had much to lose from the rising price of GameStop. The real reason why Robinhood halted trading on the insanely volatile stock may be less nefarious but nonetheless concerning. In 2018[ix], Robinhood opted to create their own clearing house for their client’s trades. Again, without going into great detail, this action allowed them to bring more of the trading process in house and thus increase their revenue. However, by doing so they also assumed much greater liability as opposed to other online traders who have resorted to using a third party for clearing house services. In addition, running a clearing house is incredibly capital intensive and highly regulated. You can read more about clearing houses and Robinhood’s decision to create their own here[x].

Robinhood’s public answer for halting trading of GameStop was that their clearing house lacked the capital necessary to process their user’s trades while also maintaining the reserves necessary to satisfy regulatory requirements. In other words, they ran out of money. While other firms did eventually briefly halt trading of GameStop as well, Robinhood was the first shoe to drop. Which begs the question, did their creation of their own clearing house in 2018 contribute to their inability to process trades in 2021? Or did their relationship to Citadel Securities influence their decision? That will be the question on everyone’s minds when Robinhood and Citadel testify before a House panel on Feb. 18[xi].

                Here’s the bottom line for individual investors: when it comes to investing and planning for your future, who are you going to trust? A large company that brands itself as “stealing from the rich and giving to the poor” while acting the part of the Sheriff of Nottingham behind closed doors? Or will you find an advisor that you can trust and have a personal relationship with? Someone who is going to give you actual advice and not just a platform to “play” with investing?

 

The choice is yours to make and rather than answer it for you I will leave you today with your song of the week! This week’s song is a new one from Chris Stapleton. That dude’s voice is insane!

Song

 

[i] https://www.businessinsider.com/personal-finance/warren-buffett-recommends-index-funds-for-most-investors

[ii] https://www.sec.gov/news/press-release/2020-321

[iii] https://www.nytimes.com/2020/07/08/technology/robinhood-risky-trading.html

[iv] https://www.nytimes.com/2020/03/11/business/bear-market-stocks-dow.html

[v] https://www.thebalance.com/fundamentals-of-the-2020-market-crash-4799950

[vi] https://www.nytimes.com/2021/01/28/business/gamestop-stock-market.html

[vii] https://finance.yahoo.com/news/robinhood-ceo-refutes-game-stop-hedge-fund-conspiracy-theory-and-reveals-what-actually-happened-234600703.html?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAAMFObZwtFfLzPOrDaclO7-X9kfzaIK-2iatEiMH9fWxkAlK3F79elJB0q--lmjTp0fRVfc4I6L7gC_KL7quT3-CG7paRfTw6P-xrOS1ey39lmyMZjJsjSFCBJ7JAnwCAxk9pWwxAy0cF2QPBhGCfR4XPtuZNMnGerLxQLRikuZiU

[viii] https://www.washingtonpost.com/business/2021/01/29/robinhood-citadel-gamestop-reddit/

[ix] https://blog.robinhood.com/news/2018/10/9/introducing-clearing-by-robinhood

[x] https://finance.yahoo.com/news/robinhood-ceo-refutes-game-stop-hedge-fund-conspiracy-theory-and-reveals-what-actually-happened-234600703.html?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAAMFObZwtFfLzPOrDaclO7-X9kfzaIK-2iatEiMH9fWxkAlK3F79elJB0q--lmjTp0fRVfc4I6L7gC_KL7quT3-CG7paRfTw6P-xrOS1ey39lmyMZjJsjSFCBJ7JAnwCAxk9pWwxAy0cF2QPBhGCfR4XPtuZNMnGerLxQLRikuZiU

[xi] https://www.reuters.com/article/us-retail-trading-usa-congress-idUSKBN2AA262